Trying to divine the evolution of the SEF landscape

I’ve been at Greenwich Associates a little over a year now. Since I’ve been here I’ve written a few blog posts about SEFs, but have otherwise not written any formal research pieces on the topic. When I started looking at this back in 2010 via SEF 101, it was a green field. Today there is an abundance of good research looking at SEFs and their impact on the market, so saying something new an interesting isn’t all that easy.

But for those of you that know me well, I of course couldn’t go forever without putting some thoughts down on (virtual) paper. In this new Greenwich Report we look at what’s wrong with the currently reported volume numbers, why the market is still in its early stages despite strong volume growth in the past few months, and what ultimately will determine the winners and losers regardless of current volume numbers. We focus primarily on the dealer-to-client IRS market, respecting the fact that the legacy D2D market and CDS market both have their own unique dynamics (that we will discuss another day).

New Greenwich Associates Report Assesses the Future of SEFs and Identifies Key Factors of Success

Tuesday, October 14, 2014 Stamford, CT USA — Although the U.S. swaps market has been radically transformed, market participants are still evaluating trading on swap execution facilities (SEFs) and how they may adapt their derivatives trading operations to comply with new regulations. A new report from Greenwich Associates, The SEF Landscape: Beyond the Numbers, reviews the changes in the U.S. swaps market since the start of mandatory trading on SEFs and assesses the future.

The new rules are changing trading practices dramatically: The share of U.S. investors reporting they trade a portion of their overall swaps trading volume electronically jumped from 23% in 2013 to 41% in 2014. Another 20% in 2014 said they plan to start trading electronically in the next 12 months.

Incumbent, RFQ Platforms at the Top

Greenwich Associates research shows that the top two platforms for investors trading interest-rate swaps electronically—Tradeweb and Bloomberg—remain the same today as they were before SEF rules came into effect with data also showing the majority of investors continue to prefer trading via name give up request for quote (RFQ), which is most similar to the old way of phone trading as is possible under the CFTC’s rules.

“For now, the complexity of the rules is what has kept many on the sidelines despite the growing benefits of trading on SEFs,” says Kevin McPartland Head of Research for Market Structure and Technology at Greenwich Associates. “Even so, the new market structure has only just started to take shape with many opportunities still on the table for incumbent, interdealer broker and new entrant SEFs.

Beyond the Numbers: Determinants of Success

Greenwich Associates believes there are five factors that will determine the success of SEFs as liquidity consolidates over time.

Liquidity: Higher SEF volumes do not always correlate with higher liquidity. While it doesn’t guarantee better liquidity, a unique set of liquidity providers can also make a SEF standout.

Distribution: The harder it is for investors to gain access to trade on a given platform, the less likely it is for that platform to ultimately be successful. As such, incumbents like Tradeweb and Bloomberg have an advantage over new entrants.

Unique Functionality: Unique functionality like compression tools, the ability to handle package trades or innovative order types may prove enough for nascent SEFs to attract the liquidity needed to gain wide distribution over time.

Pricing: High costs can be a barrier to success, and the report presents a breakdown of the cost structure for each of the major competing SEFs.

Service: In an increasingly electronic yet complex world, an investor’s ability to pick up the phone and speak quickly with someone, who is knowledgeable about both the system and the market, is critical.